This is where the financial crisis really starts. Before I go into the ramification of a default on the futures market, I need to quickly go over inflation/deflation and the money supply.

The supply of any assets is the total amount people see on their statements every month and believe they own. Similarly, the supply of money is the amount people have in their wallets plus the amount of money they have in their bank accounts (checking, savings, money-market, etc). The amount of dollars that Americans believe they own is only a fraction of the actual amount of dollars which exist.

In any modern banking system, there always exist a disconnect. Below is graph of the US money supply from 1986 until July 2009.

Inflation

Inflation is the invisible process through which the supply of money (or other asset) is inflated by lending. In inflation, the supply of money as seen on banking/brokerage statements grows despite no similar change in the actual supply of money in existence. Since the more there is of something, less it is worth, the value of an asset drops as its supply is inflated. In the supply of money, inflation happens every time a bank loans out a depositor's cash.

Example of inflation

As an example of how inflation, let's take an imaginary town (Pleasantville) where a new bank (Everbank) opens. Before Everbank's arrival, the townspeople of Pleasantville used only cash. After Everbank opens, townspeople deposit their all their money, and Everbank then has $1000 on deposit. Now Person A comes to town, takes out a 1000 dollar loan from Everbank, and then uses all the money to buy stuff in Pleasantville. As the money is spend, the townspeople deposit it all back to Everbank. Soon, Pleasantville's townspeople believe they have $2000 on deposit at Everbank, which means Pleasantville's money supply has now been doubled. Since the townspeople now see twice as much money on their bank statements and feel richer, they are willing to pay more for goods they really want and prices begin to increase. This is inflation. Of course, Everbank will keep loaning the $1000 out again and again, while the townspeople will keep depositing again and again, so the Pleasantville's money supply will keep growing and prices will keep moving higher.

Now normally, in modern banking systems, banks are required to keep reserves against deposits that slow the inflation process down. However, US regulators, in their great wisdom, decided that American banks didn't need such reserve requirements in the mid-nineties (look at graph of the US money supply above and you can easily notice the change around 1995).

Key features: Inflation is slow and invisible. It never happens all at once: Inflation happens gradually as people are slowly tricked into believe they own more and more of something. Inflation can happen in the supply of anything that can be deposited or lend (for example: replace the 1000 dollars in example above with 1000 ounces of gold/silver).

Deflation

If inflation is the process where people are tricked into believing they own more and more of something, deflation is the panic when they realize they've been tricked. In the money supply, deflation happens when banks and other institutions start defaulting on their debt (checking accounts, savings accounts, etc). The amount of money people see on their banking statements (and think they own) drops sharply as banks fail and stop sending statements. The public's reaction to deflation is panic. People start doubting the numbers they see on all bank statement and rush to withdraw their money, causing further bank failures and more panic. Because the supply of money is rapidly shrinking during deflation, the value of money rise for those lucky enough to still have it.

Deflation can only occur in an asset whose supply has been inflated. Without inflation, there is no deflation.

Finally, deflation can, at great cost, be prevented in paper money (ie: US dolla
rs) by a government determined to do so. First, deflation's contagious fear can be countered by guaranteeing bank debt (checking accounts, savings accounts, etc). Thanks to FDIC insurance, most people will not withdraw their money even if they suspect their bank to be insolvent. Second, the government can rapidly increase the actual supply of money in existence (the monetary base) by money printing to prevent banks from failing, which the US has done (you can easily see this on the graphic above). By expanding the monetary base, the fed has prevented major bank failures which might have created deflationary panic despite FDIC insurance.

Example of deflation

Despite what many believe, we have not seen true deflation in the US over the last two years. The contagious fear and hoarding involved in real episodes of deflation have been absent. To emphasize this point, I would like to point to a time where true deflation shook the US. In the passage below, Frank Vanderlip (then president of City Bank, aka Citibank) remembers the banking panic of 1907.

CHAPTER XVII1907

THE specters that haunt a banker when his world goes mad are terrible. I can tell you because I remember 1907.A "run" is always appropriate material for the nightmare of a banker. Just fancy yourself as a banker— and discovering outside your plate glass façade an ever-lengthening column of men and women, all having bankbooks and checks clutched in their hands. Fancy those who would be best known to you, the ones with the biggest balances, pushing to the head of the line— there to bargain excitedly with the depositors holding the places nearest the wickets of the paying tellers. Even that won't give you a hint of what a banker's dread is like unless you heighten the effect with a swarm of hoarse-throated newsboys, each with his cry pitched to an hysterical scream; and then give the hideous concert an over-tone of sound from the scuffling feet of a mob.

Although the depositors never gathered as a mob outside our bank, I knew the flavor of terror just from contemplating the possibility. We had the biggest and strongest bank in the country, but obviously we could not hope to be in a position, ever, to pay their cash to all of our depositors if they should demand it simultaneously. Bigness does not save an elephant staked on an ant-hill. Bigness will not save a bank if a run endures long enough. In that year, 1907, the size of the National City Bank was regarded as phenomenal in America, and more than impressive in London, Paris, Berlin and St. Petersburg. We had in our own vaults as our lawful reserves more than $40,000,000—and three-quarters of that sum was in gold.

...In a curt announcement, the public read that the National Bank of Commerce had declined any longer to clear the checks of the Knickerbocker. The depositors of the Knickerbocker believed they read in this statement something of deeper significance. They began to pour into the trust company, determined to withdraw their deposits. The Knickerbocker did not have much cash. Trust companies were not required to keep cash reserves against their deposits at a ratio at all comparable with that required of the National Banks in the central reserve cities, New York, Chicago and St. Louis, which had to have in their vaults, always, cash equal to 25 per cent of their demand deposits. Lacking cash, the Knickerbocker quickly had to close its doors.

Immediately, an already timorous public grew suspicious of most of the other trust companies, and lines of depositors began to form in front of their doors. Extra editions of the newspapers, falling prices registered in the stock-market, wild rumors, these things contributed force to the wave of emotion that engulfed the banking system.Almost every caller was some one needing to be soothed. One acquaintance who came to my desk was a man with black eyebrows so mobile from excitement they seemed likely, any moment, to scamper up his forehead and vanish into his hair. He was Julian Street, the young author, and he was clutching in a trousers' pocket something unprecedented in the pockets of all other authors I had ever known. Street had fifty yellow $1,000 bills. He explained possession credibly; the money was part of his wife's inheritance and, after an adventure, he had just retrieved it from one of the trust companies.On that first morning of the panic Street had taken fright as had every one else; you could catch the infection of terror over the telephone from the tone of a voice. A short while before a considerable part of his wife's fortune had been turned into cash. Pending reinvestment, it was on deposit with one of the trust companies; but even the strongest trust companies had become suspect. As he came down-town everywhere Street saw men and women dashing about in the manner of ants when their hill is trod on. He determined to get the money and bring it to me.

When he presented his certificate of deposit at the trust company he was invited into a conference with a vice-president. This man attempted to reason with Street; he said the company was as strong as the country itself and that it was foolish for Mr. Street to incur the risk of robbery or loss by some other means. But Street was firm, and so another official added his arguments and when he could not change the client's mind, the president himself joined the group. For nearly three hours those men argued and cajoled. Probably their pride was involved, but all that they said simply frightened Street more, until he was the personification of the 1907 panic.

"The country is in terrible shape," he said, "if you three men can spend hours making such a to-do about an account of this size.""But for your own good, Mr. Street. . ."

"Cash !" roared Street. "I want the cash. Read what it says on this certificate: payment on demand. I demand the cash."

"Not so loud, please, Mr. Street, because we are simply trying to keep you from a foolish action. What can you do with the money?"

"None of your business. I want that cash."

"Well, if you insist, let us give you a certified check."

"Cash," repeated Street shrilly, "or I go out and give the story to the newspapers."They surrendered then and gave him his bundle of thousand dollar bills...

Madness, of course, is the word for the sudden, unreasonable, overpowering fright that communicates itself through all the human herd at such a time as that to which I refer. From too much usage, the word "panic" has ceased to have its proper cutting-edge as a tool for the mind. It has degenerated into a mere time symbol in our vocabularies, a sort of asterisk, marking the calendar of our memory opposite such years as 1873, 1893, and 1907. Yet
, a banking panic, such as occurred in 1907, is actually akin to that which happens when a leaking ship's company is mastered by fear, instead of a stern captain, and rushes for the small boats, forgetful of all obligations except the brutish one of self-preservation. This swift contagion comes, when it does, as quickly as you can say the word:

"panic !"

Key features: Deflation is brutal and swift. It is the opposite of inflation:

1) While inflation robs people slowly by reducing the value of money, deflation robs people instantly by wiping out their savings.2) While inflation slowly reduces the value of an asset, deflation causes its value to spike as people (dollar's value increase sharply during the great depression).3) While people are mostly unaware of inflation happening, no one can ignore the fear and madness which deflation creates.

The three most important things to remember about deflation are:

1) The more the supply has been inflated by lending, the worse the resulting deflation.2) Deflation in hard assets can't be stoped (ie: no one can print gold or wheat)3) After the first defaults, deflation becomes self-sustaining.

Why those who believe in deflation can be ignored

Those who believe in deflation are convinced that, since the US banking sector and consumer are so overstretch, rising defaults will prevent the money supply from growing, despite the Fed's money creation. To some extent they are right: look at the graph of the money supply above. Despite the increase in monetary base, the money supply has hovered around 14 trillion for nearly a year. If the US money supply was all that mattered, those on the deflation side of the debate could be right.

If the US money supply has increased 768% in the last 30 years, So why didn't prices go up?

1980

1986

Jan-09

US Monetary Base

133

205

1,708

US Money Supply

1,823

3,232

14,000

Crude Oil ($ per barrel)

37.42

14.44

35.00

Wheat ($ per bushel)

3.91

3.08

5.30

cattle ($ per cwt)

70

58.79

82

Sugar (cents per pound)

32.30

8.40

15.67

Gold ($ per oz)

615

368

956

Copper ($ per ton)

2,234

1,456

3,000

Of course, commodity prices spiked back in 1980. Even so, Americans believe they own nearly 8 times more dollars then they did back in 1980. Although production of commodities has increased, so has demand. No matter how severe the economic slowdown, it is ridiculous for oil today to be lower than 30 years ago. Commodities in January 2009 failed to even double what they were back then.

Since deflation reverses the effects of inflation by deflating supply to what it was before, it doesn't actually make prices fall, but instead it undoes the price rises caused by inflation. If the US money supply's 768% inflation over the last three decades failed to move prices up, why would anyone expect deflation to keep them down now?

Why prices didn't go up and why they will go up now

There is a very simple reason commodity prices aren't higher despite people believing they believing they own 8 times more dollars today: people believe they own a lot more commodities too.

Remember, the supply of any assets isn't the actual amount of that asset that exists, but the amount people believe they own. Right now, the world accepts commodity futures and options (promises to deliver commodities in the future) as though they were the real thing. In the same way that people think they own the money in their checking accounts, people believe they own the commodities equal to the commodity futures and options they see they see on their brokerage statements. Below is a graph of open interest of major commodities since 1986.

Open interest on major commodities has increased 16 times since 1980! Some of this increase in open interest is spread trading (traders buy one futures contract and sell another), but most of it is inflation: financial institutions pledging to deliver commodities they don't have.

In case someone thinks that the massive increase in promises to deliver commodities is natural, below is the open interest graph for copper and cocoa (used to make chocolate) over the same time period. These two commodities are examples of more normal increases open interest (notice how open interest remains nearly unchanged in the last six years).

[Unfinished]

Stage 3: The collapse of US credit markets

This is where the dollar enters a freefall.

Collateral backing futures contracts will be sold

Inflation fears will drive investors out of treasuries

A large number of investors, expecting deflation and falling prices, are invested in US treasuries. These investors are going to somewhat surprised and . Once they understand what is going on (maybe by reading this article?), their shock will turn to horror and they will begin dumping treasuries as fast as they can (IF they can find anyone to buy them).

The Fed will start selling.

Faced with surging food prices, the Fed's first reaction will be to sell assets and shrink its balance sheet. Of course, under intense pressure from the treasury, the fed will reverse course and start buying treasuries again. However, for the first month or two, the Fed will be amoung the sellers of US debt.

China will break the dollar peg

If China lets domestic food prices double or triple, not only will it kill off the domestic growth driving its economy, but it will also cause all types of social unrest. China would even need to think . Chinese exporters will be badly hurt, but that will be a small cost if it can keep food prices down.

The rest of the world will sell US treasuries

With the price of food and cheap consumer goods (from China) skyrocketing, any country that has any reserves will sell them.

------

In fact, after food prices spike and china drops the dollar peg, I can't think of anyone who would want to buy US debt. It will not be pretty.

Leading Newsletter Paints A Grim Picture Of The FutureSome U.S. embassies worldwide are being advised to purchase massive amounts of local currencies; enough to last them a year. Some embassies are being sent enormous amounts of U.S. cash to purchase currencies from those governments, quietly. But not pound sterling. Inside the State Dept., there is a sense of sadness and foreboding that 'something' is about to happen ... within 180 days, but could be 120-150 days."

--------------------------------

"But the dollar can't collapse because there is no alternative to the US dollar for a reserve currency..."

I love the "there is no alternative to the US dollar for a reserve currency" argument. Every time I hear it, I imagine someone standing on the deck of the Titanic on the night of April 14, 1912, and declaring, "This boat can't possibly sink because there aren't enough lifeboats!"

The lack of viable alternatives doesn't mean the dollar can't sink, it simply means that when it does go down, it will result in a tragedy of epic proportions which will be remembered for centuries to come.

How did we get to this point? Well, the treasury is the root of the problem.

Treasury Encroachment into the US Capitalistic Economy

Below is a value of the dollar's value since the creation of the Fed, which clearly shows how go make clear that is responcible for devaluation of the currency.

The Federal Reserve Act of 1913

The seeds of the dollar's destruction were planted back in 1913, during the creation of the Federal Reserve, when the US Treasury proposed making the dollar into a fiat currency (a currency backed by taxpayer guaranties rather than a hard asset like gold). While Wall Street had wanted a central (to help prevent another banking panic like 1907), then Secretary of the Treasury, William McAdoo, proposed a rather radical bill, a Federal Bank issuing US currency, backed by the taxing authority of the government.Wall Street (which wasn't yet the corrupted mess it is today) saw the danger and opposed violently.

Even as Glass and Wilson presented the revised plan to Congress and the country, bankers were waging an intense campaign against the bill. The level of panic they felt now seems quite remarkable, but in 1913 the proposal, as Link reminds us, constituted an unprecedented level of "government intervention in the most sensitive area of the capitalistic economy." Meeting in Chicago, the country's leading bankers demanded, essentially, a return to the Aldrich plan, while in Boston the House bill was denounced as socialistic by a convention of the American Bankers' Association. Prominent conservatives such as Frank Vanderlip of National City Bank, the railway magnate James J. Hill, and Senators Aldrich and Root condemned the democratic bill as the embodiment of populist schemes, a generator of "fiat" money, and a step towards socialism. Academic opinion in the core was also hostile. Yale President Arthur D. Hadley, a respected economist, wrote President Wilson that the Glass-Owen program would "involve the country in grave financial danger." Prominent professors concurred with Aldrich at a meeting of the Academy of Political Science, condemning the bill's dangerous absence of limitation on note issue. The result of such a legislation, editorialized the New York Times, would be the opening of "a fathomless abyss of inflation." The banking Law Journal editorialized that the bill constituted "a proposal for the creation of a vast engine of political domination over the forces of profitable American industry.... The fight is now for the protection of private rights and to be successful it must be waged to enlist public opinion against unwise legislation with tendencies to financial disaster to all the people."

Prior to Federal Reserve Act, Banks could issue bank notes against specie (gold and silver coins) in their vaults, supervised by the office of Comptroller of the Currency which regulated reserve requirements, interest rates for loans and deposits, the necessary capital ratio etc. Dollars were printed by the Comptroller of the Currency to ensure uniform quality and prevent counterfeiting. In this system, the control over the US money supply was divided between banks and Government: banks held the power to issue currency against the gold in their vaults and the Comptroller of the Currency controlled how many dollars they could issue against this gold through regulation (reserve requirements, etc). Though it had its flaws this system worked well to preserve the value of the dollar over time, as demonstrated in the chart belo
w.

Historical purchasing power of US dollar thru 2004 (American Institute for Economic Research)

With the Federal Reserve Act of 1913, the balance of power over the US money supply shifted strongly in favor of the Treasury. Instead of dollars being against the gold in vaults of private banks, dollars were now issued against the gold held at the Federal Reserve, which was part controlled by Washington. Furthermore, making the dollar backed by the US taxpayer provided justification for much greater government, resulting in the Gold Reserve Act of 1934 and The Banking Act of 1935.

The Gold Reserve Act of 1934

The Gold Reserve Act increased concentration of power over the US money supply in the hands of Treasury. In 1934, The Gold Reserve Act passed through Congress in five days, with minimal debate. Under this act, the Federal Government took away title to all "Gold Certificates" and gold held by the Federal Reserve Bank (the independent Fed?) and vested sole title with the U.S. Treasury.

The day after the passage of the Gold Reserve Act, President Roosevelt fixed the weight of the Dollar at 15.715 grains of Gold "nine-tenths fine". The Dollar was thereby devalued 40.94% from $20.67 to one troy ounce of Gold to $35.00 to one troy ounce of Gold. The Treasury, which had become the possessors of all the nation's Gold on the previous day, saw the value of their Gold holdings increase by $US 2.81 Billion. The Treasury now "owned" the Gold, and no one else inside the U.S. was allowed to own any Gold except by the express permission of the Treasury.

Furthermore, A provision in the Gold Reserve Act also established The US Exchange Stabilization Fund. The fund began operations in April 1934, financed by $2 billion of the $2.8 billion paper profit the government realized from raising the price of gold to $35 an ounce. The ESF was designed as a creature of the Executive Branch not subject to legislative oversight. The Gold Reserve Act authorized the ESF to use its capital to deal in gold and foreign exchange in order to stabilize the exchange value of the dollar.

The Banking Act of 1935

The Banking Act of 1935 effectively moved the power center of the Federal Reserve from New York to Washington D.C. Prior to 1935, the Federal Reserve Board members in Washington, D.C. were significantly less powerful than the twelve heads of the regional Federal Reserve Banks. These regional heads were called Governors and had the power to conduct open market operations (buy/sell securities). However, the banking act changed the titles of regional district heads to "President" and stripped them of their ability to conduct open market operations. Meanwhile, it increased the salary of the Federal Reserve Board members and gave them the title of Governor (creating The Board of Governors of the Federal Reserve we know today). The open market operations were also concentrated at the New York Fed under the board's control. Finally, The Board of Governors of the Federal Reserve was moved from New York to Washington. The Banking Act of 1935 enormously increased the power of the president-appointed 'Chairman of the Federal Reserve Board.

Other important changes

Finally, a change in the law, in 1970, allows the Secretary of the Treasury, with the approval of the President, to use money in the ESF to "deal in gold, foreign exchange, and other instruments of credit and securities."

The Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA) [1] is a United States federal law enacted in the wake of the savings and loan crisis of the 1980s. It established the Resolution Trust Corporation (RTC) to close hundreds of insolvent thrifts and provided funds to pay out insurance to their depositors. It moved thrift regulatory authority from the Federal Home Loan Bank Board to the Office of Thrift Supervision (OTS) (within the United States Department of the Treasury) to regulate thrifts.

The Working Group on Financial Markets (also, President's Working Group on Financial Markets, the Working Group, and colloquially the Plunge Protection Team) was created by Executive Order 12631, signed on March 18, 1988 by United States President Ronald Reagan.

Why are all the rule changes above important? Because they set the stage for Treasury to begin manipulating US markets.

Basically, it all started with [former US Treasury Secretary under the Clinton Administration] Robert Rubin, back when he was the head of Goldman Sachs in London. He would borrow gold from the central banks at a 1% interest rate, and then sell it. He took this idea and made it the essence of his "Strong Dollar Policy" [while at the US Treasury].

During Rubin's tenure at the Treasury, we had the SouthEast Asian currency collapse of '97, the South American currency collapse of '98, and the Russian Ruble collapse of '98.Although historically such foreign currency crises normally would have ignited the precious metals sector, but Robbing Rubin utilized his power at the Treasury to drive the gold and silver prices into the ground during these various regional currency crises. The government was interfering in the markets before, but Rubin took it to a whole new level.

(There many allegation that US "Deep Storage Gold" does not exist or is encumbered.)

Statistics from United States Geological Survey show that the united states has exported 5000 metric tons of "Gold compounds" in last two years, and the US Census Bureau has assigned an astronomically high value to these exports. Until someone explains to me what these
"gold compounds" are, I am going to assume that they were half the US gold reserves leaving the country.

... in a 1992 article, John Crudele quoted someone who maintained strong connections in the Republican Party as stating that the government intervened to support the stock market in 1987, 1989 and 1992:

Norman Bailey, who was a top economist with the government's National Security Council during the first Reagan Administration, says he has confirmed that Washington has given the stock market a helping hand at least once this year.

"People who know about it think it is a very intelligent way to keep the market from a meltdown," Bailey says.

Bailey says he has not only confirmed that the government assisted the market earlier this year, but also in 1987 and 1989.

...Referring to the U.S. Exchange Stabilization Fund, he wrote, "Sources have told me that in the early 1990s it was secretly used to bail the stock market out of occasional lapses." He further stated one source indicated "that the account used Wall Street firms as intermediaries and that Goldman [Sachs]... was used most often as a go-between."

The Fed's denial of stock market activity, combined with claims that the Treasury controlled ESF did intervene, is intriguing when considered in the context of two 1995 Federal Open Market Committee transcripts.At the January 31 meeting, St. Louis Federal Reserve President Tom Melzer expressed concern about the Fed's proposed participation with the Treasury in the bailout of Mexico then under discussion. The Clinton administration had decided to use the ESF to fund the rescue when Congress refused to grant an appropriation. Melzer worried:In effect, one could argue that we would be participating in an effort to subvert that will of the public, if you will. I do not want to be too dramatic in stating that. This could cause a re-evaluation of the institutional structure of the Fed in a very fundamental and broad way.35

To which Greenspan cryptically, yet ominously, responded:

I seriously doubt that, Tom. I am really sensitive to the political system in this society. The dangers politically at this stage and for the foreseeable future are not to the Federal Reserve but to the Treasury. The Treasury, for political reasons, is caught up in a lot of different things. [Emphasis added.]

At the March 28 meeting, FOMC members again expressed hesitation about the Fed's planned participation with the Treasury in the Mexican package. Once more, Greenspan attempted to alleviate any fears, but also noted:

We have to be careful as to precisely how we get ourselves intertwined with the Treasury; that is a very crucial issue. In recent years I think we have widened the gap or increased the wedge between us and the Treasury.... In other words, we have gone to a market relationship and basically to an arms-length approach where feasible in an effort to make certain that we don't inadvertently get caught up in some of the Treasury initiatives that they want us to get involved in. Most of the time we say "no." [Emphasis added.]These passages obviously suggest that by 1995 the Treasury was engaging in activities that Greenspan deemed politically dangerous and, accordingly, with which he was very reluctant to be associated. It is only logical that these actions had not been disclosed publicly by the time he made these two statements. Had they been public, the Treasury would have already suffered the consequences of the political dangers of which Greenspan spoke.

How the treasury's ESF manipulates the stock marketThe Treasury's ESF buys options and futures in order to manipulate stocks. This works because Wall Street banks balanced their book, That is to say they match up their asset and liability. When a firm (ie: Goldman, JPMorgan, etc) sells S&P; futures to the ESF, it is establishing a short position or a liability in the stock market, and balancing this short position requires buying stocks.

Wall Street firms may not know for whom they are selling futures contracts to because of the Fed's role as a proxy for the treasury. Since the treasury doesn't have the facilities to conduct open market operations (buying/selling securities), it uses the Fed's System Open Market Account (SOMA). The New York Federal Reserve official in charge of the SOMA therefore has three vital roles: he is responsible for conducting the Fed's open market operations, managing the Exchange Stabilization Fund (ESF), and managing the foreign custody accounts held at the NY Fed.

The 1997 mini-crash

The October 27, 1997 mini-crash is the name of a global stock market crash that was caused by an economic crisis in Asia. The points loss that the Dow Jones Industrial Average suffered on this day still ranks as the sixth biggest points loss in its 112-year existence. The crash also halted trading of stocks on the New York Stock Exchange for the first time ever.

In response to crashing equity markets, the treasury's ESF bought 30,000 S&P; 500 futures contracts from Wall Street firms in October 1997. These firms then had to go out and buy an enormous quantity of stocks to bring their books into balance. This buying is what preempted a politically undesirable freefall, turning a crash into a mini-crash.

The Treasury's actions worked. On October 28, The U.S. stock markets initially continued their drop from the 27th plunging down 186 p
oints by 10:06 AM, but then abruptly ended their decline, and started climbing. Twenty eight minutes later at 10:34 A.M., the Dow rallied to a triple-digit advance up 137.27 points. Prices continued to soar throughout the rest of the day, and at the close of trading the Dow finished with a record 337.17 point gain (recovering 61% of the previous day's loss).

Sinking ships & dishonest systems

Ever since Rubin, dollar has been living on borrowed time. In a system that has no future, people begin living like there is no tomorrow. This is why Goldman (the firm most aware of the Treasury's shananigans) went from "long-term greedy" to "short-term greedy"

I am not claiming that everyone on Wall Street has first hand knowledge of market manipulation (No one has proof of anything because no one knows what is going on. Regulators have created a system with no transparency). However, anyone who has been on Wall Street for any length of time knows that something is horribly wrong. Take last year's Bear Stearn put options as an example

On March 10, 2008, Bear Stearns stock dropped to $70 a share -- a recent low, but not the first time the stock had reached that level in 2008, having also traded there eight weeks earlier. On or before March 10, 2008, requests were made to the Options Exchanges to open a new April series of puts with exercise prices of 20 and 22.5 and a new March series with an exercise price of 25. The March series had only eight days left to expiration, meaning the stock would have to drop by an unlikely $45 a share in eight days for the put-buyers to score. It was a very risky bet, unless the traders knew something the market didn't; and they evidently thought they did, because after the series opened on March 11, 2008, purchases were made of massive volumes of puts controlling millions of shares.On or before March 13, 2008, another request was made of the Options Exchanges to open additional March and April put series with very low exercise prices, although the March put options would have just five days of trading to expiration. Again the exchanges accommodated the requests and massive amounts of puts were bought. Olagues contends that there is only one plausible explanation for "anyone in his right mind to buy puts with five days of life remaining with strike prices far below the market price": the deal must have already been arranged by March 10 or before.

..."To prove the case of illegal insider trading, all the Feds have to do is ask a few questions of the persons who bought puts on Bear Stearns or shorted stock during the week before March 17, 2008 and before. All the records are easily available. If they bought puts or shorted stock, just ask them why."

"Even if I were the most bearish man on Earth, I can't imagine buying puts 50 percent below the price with just over a week to expiration," said Thomas Haugh, general partner of Chicago-based options trading firm PTI Securities & Futures LP. "It's not even on the page of rational behavior, unless you know something."The 57,000 puts that traded March 11 at the $30 strike price and the 1,649 that traded at $25 were collectively worth about $1.7 million, Bloomberg data show. Each put is equal to 100 shares of stock.

"That trade amounted to buying a lottery ticket," said Michael McCarty, chief options and equity strategist at New York-based brokerage Meridian Equity Partners Inc. "Would you buy $1.7 million worth of lottery tickets just because you could? No. Neither would a hedge fund manager."

Imagine you saw a bank being robbed in broad daylight. The police are there, but ignore it completely. A year later, not only is no one in jail, but an investigation hasn't been started.How would you feel about the long term prospects and stability of the country where you watched this happen?

The buyers of puts on Bear Stear committed a crime, highly profitable insider trading. They should be in jail, yet they are not. US regulators never made any attempt to put them there.

How can anyone in the financial world, who watches such crimes happen on a regular basis, have any faith in the long term viability of the US financial system?

Wall Street behaves like there is no tomorrow

Treasury interference in US market corrupted corporate culture. Bankers started behaving like there was no tomorrow because they knew something was fundamentally wrong with the system. They started pursuing business practices which can only be described as "picking up pennies in front of a steamroller".

Well, you predicted that dollar collapse will start when the US runs out of soybeans by the end of the summer and I think this requires some explanation, because soybeans futures are in free fall due to record harvest expected this year. Seems like you did not get this one right. Since it is the first step, why should you bother with the next steps if the first one is not happening and what is going on is rather the opposite? Shouldn´t you say something about this?

It is not up to a well-read passenger of the vessel to indicate where the life boats are. You are responsible to create your own life boat and many bloggers are already secretly and silently acting upon what is said in the emergency notifications. Farmland, get access to the basics, gold, silver, etc. You can as far as you want to go. All info is on the web. You also do not have to believe his story. That's the beauty of the internet.

If you want to know what type of 'lifeboat' you need to be looking for. Let's say you were on the Titanic and the Titanic had a bank. By the fractional reserve process the Titanic bank could produce paper lifeboats to the fractional reserve rate (which at present seems limitless). Promising spaces or complete lifeboats to those who bought paper certificates. Now there are more lifeboat spaces than actual lifeboats on the ship. Everyone can rest assured that they have an insurance policy from the 'unsinkable' Titanic's bank.

Oops it hit the iceberg! Now you will find what that paper promise is worth and the meaning of counterparty risk. Unless you are sitting in a real lifeboat floating away from the sinking ship you are in trouble. So a 'lifeboat' is a real asset. It exists, you can physically own it, you can phyisically touch it. It does not depend on anyone else's promise. All you have to do to identify such lifeboats is to apply such critera. As stated, gold, silver, farmland, commodities etc are real assets. Paper is well paper and depends on the ability of a third party to deliver, the counterparty risk! Do you want a seat on a real lifeboat or a paper promise of one. Note there were not enough lifeboats on the Titanic for all the passengers. As with this financial 'Titanic': there are not enough real assets to cover the paper promises to those assets. The Titanic the biggest ship in the world at that time sank very quickly into what were then the bottomless depths. The current financial crisis is the biggest in the history of the world what makes anyone think there is going to be a different outcome?

I find your terminology regarding your stage 2 "Deflation in US commodity markets" confusing, because it seems that you're not really referring to a monetary phenomenon at all. And you're not expecting prices to drop, as would happen in a classic deflation.

On the contrary, I think you're predicting that a major default or delivery failure will cause a general panic among people who own futures contracts, futures-based ETF's and so forth -- driving commodity prices upwards. Is that correct?

If so -- we can expect that the PPT, the Fed, the Treasury, the ESF and so forth, will do whatever they can to contain the crisis. What options do they have?

(1) In the event of a shortage of physical product for settlement, the contracts can be settled in cash. If the cash price is high enough to cause financial distress for some bank or other institution caught on the short side, that institution can be bailed out at public expense.

(2) Note that if holders of long commodities contracts are in a panic, the effect is actually to hold futures prices down. Because if you're in a panic about whether your futures exchange or your oil ETF is going to default, then you SELL, right? But this act of selling would act to hold the price down. Very few owners of oil or agricultural commodities futures are in a position to take actual physical delivery of massive quantities of the commodities for physical storage.

So it might actually be to the Fed's benefit to allow a few bankruptcies or defaults in the commodities sphere. The resultant (poorly controlled) panic would help to hold commodity prices down.

The bad effects of all this would be more delayed: with a general failure of confidence in futures markets, participants can't trust those markets for traditional hedging purposes, and thus the overall level of economic activity would continue its decline. Also, if commercial users of commodities lose faith in the futures markets as a place to lock in prices for their expected needs, then their alternative is to build up their real physical storage capability (that is, hoarding) which of course causes price inflation.

And in the case of gold & silver, these are relatively easy to store in physical form, so a panic failure of the futures markets certainly would drive prices upwards.

However, if the price of precious metals (or any other commodity) goes too high, too fast, then inevitably a bubble results and a crash follows. The crash of precious metals prices in the early '80s was, I believe, a crucial factor in saving the system from hyperinflation at that time -- no one could jump onto gold as a lifeboat, because the lifeboat was sinking.

Who are the winners in the quadrillion dollar derivative game? Is the money going to private bankers?

I recall the words of Thomas Jefferson: "If the American people ever allow private banks to control the issuance of their currencies, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their prosperity until their children will wake up homeless on the continent their fathers conquered."

Is this what America is facing in the coming years?

I'm not American but Swedish so I guess I don't have to worry that much, even if the dollar collapse surely will sink our economy too, and send commodity prices skyrocketing.

By the way, wooden coins would fit well in a hyperinflation; wood is a cheap material when nickel becomes way too expensive compared to the coins' nominal value, and wood is also great to burn, much better than paper notes. Sweden is rich on forests, so I think we are headed for wooden coins.

"Imagine you saw a bank being robbed in broad daylight. The police are there, but ignore it completely. A year later, not only is no one in jail, but an investigation hasn’t been started.How would you feel about the long term prospects and stability of the country where you watched this happen?"

Just one complaint. Your definition of "deflation" is a confusing non-sequitur.

If inflation is the money supply expanding (or prices going up, if you like), then deflation is the money supply contracting (or prices going down).

"Realizing the past inflation" may be a CAUSE of deflation occurring, but it is not deflation itself -- it is the trigger event of actions which result in a catastrophic deflation.

Further, later in your article, you even post data that admits we had gradual deflation from 1800 to 1900. This had nothing to do with "people realizing the past inflation", as there was none, with that particular monetary regime (gold backed).

It would be better to separate "deflation", which exists naturally in a benign, gradual (I'd say beneficial) form, from "deflationary panic", which is induced by artificial monetary inflation, and is therefore a negative event.

There is so much confusion over this, it is ridiculous. And "fears of deflation" play right into the Fed's inflationary regime. "We can't let there be deflation!" That was the rallying cry of the interest rate suppression that fuelled the housing bubble.

Thanks Eric,Perfect clear explanation. As I see some questions here - I start to ask if I understand everything even if looks perfect logical for me now.

Simple:- Inflation and deflation (as its counterpart) can occur in ANY kind of (hard) assets. For example - if on the small bazaar (with CONSTANT demand!) - you have to many farmers who are selling tomatoes ... there is "INFLATION in tomatoes" on this bazaar - AND automatically the price of tomatoes measured in the other (hard) assets will - DECREASE.Opposite case is with when there are to few farmers with tomatoes. Than you have "DEFLATION in tomatoes" - and price of it will INCREASE. It is simple to understand and it is self correcting.This kind of INFLATION/DEFLATION is not the same as MONETARY one.Simple.

Today - in the fiat money system - the currencies (paper promises) are NOT "hard" assets. They are "produced" by governments - especially US since this system IS "US made".Opposite:In this story Eric cited - the US dollar (or paper promise) WAS a "hard asset" since it was connected to the - GOLD by the Law.In this instant - when bankers who INFLATED amount of dollars (with paper promises, checks and so on...) were NOT able to fulfill their obligation to deliver - given amount of US dollars (or GOLD!) - it comes to DEFLATION panic. That is perfectly clear and also historically approved since the hardest DEFLATION was just wiped away in 2 months since the US government "cut" connection between dollar and gold.

Today, obviously, the governments especially those in US sphere of interest - implements "Quantitative Easing" - aka "printing of promises". Virtually - they can print as much promises as they will. (As Noumonic often repeat - even in case of extreme - the government always can go to "denomination" i.e. the "bigger" banknotes... (more 000000....). So the government is always in position to "fulfill" its obligations.

Everything is just fine - until ANYBODY insists on fulfillment of obligations to deliver REAL goods (HARD asset) promised on the "paper" ("derivates" for example...).Since there are NOT ENOUGH HARD assets (at least NOT as much as those on paper promises!) - we have DEFLATION in REAL goods (HARD assets) on the one side - and worthless paper "promises" on the other.

The ONLY solution for this situation is again 1000s years old one - exchange REAL goods for HARD assets.And it looks that we are just in this situation now.Chinese and everybody on the Globe - already know that US government CAN NOT (!) fulfill its obligations regarding HARD assets "promised" by derivates and other leveraging tools "made in US". IT is the main reason that Chinese (and others) try to exchange as many US government "promises" as they can...They know that inevitable finish - coming sooner or later, AND they try to protect themselves as good they can.

"Today, obviously, the governments especially those in US sphere of interest..."

Do you know many nations are in the "US sphere of interest"?

How about 85% of all the nations in the world...

"And it looks that we are just in this situation now.Chinese and everybody on the Globe - already know that US government CAN NOT (!) fulfill its obligations regarding HARD assets "promised" by derivates and other leveraging tools 'made in US'."

You think that matters?

Look combined together monetarily, economically the US and its "sphere of interest" would over power China, Russia, India, Brazil and the others in that they wouldn't have a chance of economic survival - if they chose to work together against their interests.

See you, and those like you, only look at this through one perspective: economics.

But the world is not govern by economics...

It's govern by the wishes of those in power...

China, and those like it, can't do shit, for if it could it would have already done it by now.

And the reason why it hasn't is simple: its actions would incite war.

Until Eric, you, or others like you can prove without a shadow of a doubt that what you say is going to happen is actually congruent the actions of China, and those like it, - that they are in fact dropping from the dollar peg - you all will go on looking like insane people, out of touch with reality.

"Perfect clear explanation."

Was it? I'm not so sure...

The majority here seem to be left asking more questions then walking away feeling like their confirmation biases were confirmed, unlike you...

Many had articulate questions that revealed holes in Eric's ideology (Marx's meaning of the word)... I particularly liked the one on soybeans.

Its funny though, you deny me here, but even Eric knows what all this will bring if nations do decide to de-peg...

And isn't going to be fun and happy days, where those that bought into metals or farmland will find nirvana.

What you are explaining is changes in Supply/Demand of a good and has nothing to do with 'Credit'.

Inflation is when a bank who owns only 100 kg of gold has given out recites to the public for 300 kg of gold. That deflates the value of the recite of the person who deposited the 100 kg of gold in the bank. Devaluation.

These extra recites in the system for gold that does not exist is now being used to buy goods and services and to speculate with causing prices to go up (IE not by changes in Supply/Demand). This fuels bubbles and mistrust by suspicious recite holders who now all want their gold back but there is no gold for all recites. And we thus get deflation. In which the supply of these recites are destroyed and the value of the original recite is again restored.

Eric makes a good point. If there truly was Deflation there would be a reduced money supply going hand in hand with a stronger USD. As most of you probably know the USD Index is hovering around 78 as we speak.

"...This fuels bubbles and mistrust by suspicious recite holders who now all want their gold back but there is no gold for all recites. And we thus get deflation. In which the supply of these recites are destroyed and the value of the original recite is again restored...."

Anon,I think that your logic in this case are not so correct.

From beginning:1. bank had deposit of just 100kg gold (HARD asset)- and issued recites ("paper derivates") for 300kg of it.2. if mistrusted "recite holders" come to run on bank - it will default. Perhaps, JUST FIRST couple "recite holders" can get their gold back... theoretically up to 100kg.3. ALL OTHERS getting nothing for their recites ("paper derivates")... theoretically up to 200kg of NON EXISTENT "gold".With other words - they have in their hands - worthless paper.

"the value of the original recite" - as you believe - CAN NOT be "restored".Namely, those are JUST "paper derivates" (worthless paper) - AND as you remember from point 2 - all "original recites" are ALREADY exchanged for REAL gold.

Additionally:"...Do you know many nations are in the "US sphere of interest"?..."

Not so much as you believe, but you already know (or you are heard about it)... namely, Anglo-Saxon sphere of interest.

Regarding "war" you mare talking about...YES.USA can try to escape the crises with war.It would be the worst possibility for complete Planet including USA.

You are probably aware that other nations are not just sheep and will wait until US "glorious" military "democratizate or liberate" them.By the way, all of those big nations have enough weapon to destroyed the Earth alone.

Simple, I am not sure that US can threaten with military to ANY of those countries. (Obviously, that US can not oppress much smaller countries as Iraq and Afghanistan neither.)

1) It finances the biggest entitlement of them all, which is the military industrial complex.

2) It serves to bully the countries that have desirable resources but don't have nuclear capability yet. Note that nations without bombs get left alone.

Because only non-nuclear nations can be bullied by the US war machine, the US is in love with preventing nuclear proliferation.

Also nuclear powers that have allowed US soldiers in find they just won't go away. We're still in Japan, even.

No, the world will shrug off the US parasite very shortly, and this empire will utterly collapse. It happened to the British empire just before the USA one rose to prominence. Why did the British empire collapse? "The sun never sets on the British empire!" It collapses because the USA cut off credit. The pound sterling lost 80% of its value in a matter of years. The British military capacity evaporated.

Now it's USA's turn.

And here's a pre-emptive f*** off for our old friend anon's obligatory mainstream media ruling elite party line.

Reconsider buying dba:- it is only promise from Deutsche Bank it holds a bunch of promises (future contracts which can be defaulted),- there even exist no free market with those promises and- you even never know if you have spent money for dba stocks or for promise to deliverdba stocks

I am 0% interested in having a discussion about Politics/War. So take it elsewhere. Thanks!

I was trying to illustrate what money IS. That it IS credit these days. I was also trying to illustrate that the money supply is closely related to Credit and Banking. If one do not understand these facts it is impossible to have a discussion about what Inflation/Deflation is.

I think we can all agree though that in the end Inflation is an increasing money supply that Devalues the fiat currency for the country in question. Deflation is when the money supply shrink and causes the fiat currency in question to Appreciate.

One good example of a country that will probably experience a hyper inflationary depression is USA. While an example of a country that will experience hyper deflationary depression could be the 'Euro Zone'. Just in regards to money supply.

Anon,Regarding "war option" - I agree with you 100%. IT is NO an option!

Regarding your last conclusion with example of hyper-inflation/deflation, I could unfortunately just agreed with it.I think that Eric also talk about it on his previous discussions.

Simply explained:US is very "effective" state with simple possibility to "print" even bigger amount of fiat money - if necessary. It could lead to hyper-inflationary depression.EU is extremely ineffective bureaucratic "state" and has very little ability to get agreement between member states - about ANYTHING... It is also valid for "Quantitative Easing" (money "printing") - can not be applied with same efficiency as in US. It could lead to hyper-deflationary depression. Or simple - EU politicians are not "better" than US (perhaps they are even worse), but they are very ineffective and in kind of such epic economic impacts - it could lead to the totally different outcomes.

Personally, I think that even if deflationary depression has probably much worse impact on the citizens at the beginning - it is much shorter and actually it "clean" the system of the "worthless paper". If this volatile impact is sustained (survived) - the perspective for further development on this area (EU) is MUCH better than on the area which is influenced by hyper-inflationary depression i.e. US even if this kind of impact could from the beginning look much "softer".

You make interesting points. But allow me to be so bold as to suggest that the more Inflation printed the more Deflation you end up with. They are both a result of having a Fiat currency system in place. Al tough the effects of Inflation/Deflation can happen with paper markets for precious metals as well. 1.3 Quadrillion derivative market anyone? Compared to a global GDP of 65 Tr USD!!!

I could be wrong but taken from you're broken English and the name 'Natasa' I assume you are from Russia?

Russia reminds me of Canada, full of natural resources. If I was king of Russia I would just make a spectrum of my natural resources into the money of choice. That would tilt away power from EU/USA into Russia. I think that is highly needed because of the creeping totalitarianism begging to rare its ugly head both in EU/USA that will probably lead to a Post-Globalization world of semi Globalized Feudalism. That is NOT a world I want to live in.

China is only 10% of total global economy they can not possibly fill the consumer gaps of the combined US, EU and japanese total of over 50% of total global economy. China is overpopulated and CAN NOT project its military power anywhere except in real force. The US has military control of over 50% of total global oil supplies and the ones they do control are the cheapest, easiest to exploit fields on earth. Forget Brazil, venezula, Nigeria etc. They have Saudi arabis, Iraq, Kuwait and could walk into Iran anytime they want. China may have money but many of the countries they buy vital resources from are allied to US interests. Its in NOBODIES interest to have the US dollar collapse that includes China and russia. They would be just as $%^$ed as the US if their little US dollar piggy bank was worth SFA overnight. You can't buy resource with $2 nick nacks.

USA has OPEC by the balls if they switch to natural gas for transport as looks like they will soon Russia and OPEC might as well bend over and kiss ass goodbye.

Russian farmland may be fertile but their overall economy stinks. Remeber this is a country where as a tourist if your not carrying visas, identification and a handfull of other documents at all times you get arrested. Most of the time if your foriegn you'll be put in a situation you have to pay bribes anyway.

Russia is far from a Utopian society and I would agree with you're observation regarding the US$. However, in time (30 years?) the US$ will most likely not be the worlds reserve currency.

USA will not just roll over and die. Private consumption in the American economy of almost 10 Tr US$ annually. In china that figure is 1 Tr US$. But there might be some sort of 'mix' of a couple of paper, fiat or dare I be so bold to say DIGITAL currencies? Because in all fairness when people referrer to current state of affairs as 'paper' in a derogatory way they get it wrong. Because the 'fake' economy is mostly zero's and one's in computers these days. (High Freq. Trading anyone?)

Don't ask me, I've never even heard of DBA USO, CAD. I don't pretend to be an investment expert.

I favor silver over gold until silver gets back into 1:15 territory with gold.

Physical precious metals are the only thing you can be sure of, all paper promises are questionable.

Lately I've grown suspect of all ETF's, whether they're supposed to hold stocks or precious metals or whatever. I think there might be a systemic fraud going on. You want to invest in X, therefore you buy the matching ETF. In reality they take your money and invest in wherever, but not in X. So your investment has no affect on the price of X. When you sell, you get the price of X due to other market forces elsewhere.

Morgan Stanley got nailed for this with silver, but received a slap on the hand. So the practice is almost certainly widespread and encouraged by the corrupt Federal Reserve / US government.

The purpose of ETF's is to manage the price of Gold and Silver. If you have any ETF's get rid of them and pull out you're money as fast as possible. It is just a way to absorb demand for precious metals. They hold NO precious metals and how can I be sure of that? Because there is not enough Gold on this whole planet for all the worthless paper or shall I say digital recites the ETF's have sold.

There is 150 k Ton of Gold above ground and approximately 50 k Ton of Gold below ground and these ETF's have sold 80 TIMES more then all of that combined. It is all fiction just like the stock market. Over 70% of the stock market is made up of machines and algorithms front running those last few procent of retail investors left in the market.

And in recent weeks if you look at the leaders of volume on the American exchanges the rest of the 30% of trades is done mostly in Bank of America and a few other Government controlled banks.

And by the way the same thing is going on on every single stock exchange in the world including FOREX, Commodities and Derivatives etc.

Pull out everything you have from the system and buy land, physical gold, physical silver, guns etc etc etc. And let these asshole mother fuckers trade nothing and the speed of light.

First you try to fuck it, then you try to eat itIf it hasn't learned your name, you better kill it before they see itFirst you try to fuck it, then you try to eat itIf it hasn't learned your name, you better kill it before they see it

It's Arma-goddamn-motherfuckin-geddon(Fuck, eat, kill, now do it again)It's Arma-goddamn-motherfuckin-geddon(Fuck, eat, kill, et cetera)First you try to fuck it, then you try to eat itIf it hasn't learned your name, you better kill it before they see itIt's Arma-goddamn-motherfuckin-geddon

First you try to fuck it, then you try to eat itIf it hasn't learned your name, you better kill it before they see itFirst you try to fuck it, then you try to eat itIf it hasn't learned your name, you better kill it before they see it

It's Arma-goddamn-motherfuckin-geddon(Fuck, eat, kill, now do it again)It's Arma-goddamn-motherfuckin-geddon(Fuck, eat, kill, et cetera)On the news, or is it the noose?The same results may vary, side effects all varyIt's Arma-goddamn-motherfuckin-geddon

It's Arma-goddamn-motherfuckin-geddon(Fuck, eat, kill, now do it again)It's Arma-goddamn-motherfuckin-geddon(Fuck, eat, kill, et cetera)Fuck the goddamned TV and the radioAnd fuck making hits, I'm taking credit for the death tollIt's Arma-goddamn-motherfuckin-geddon

Eric works hard to create a truly exceptional blog. Why do you have to try to ruin it with your bogus marketbreeze BS? I hope you and all the other twisted brothers like you roast in hell. Guess what Viper, that hell is going to be here in the US real soon!! Maybe you are lucky enough to live some where else?

Thanks to a few good people like Eric, some of us might even survive the hell and prosper.